This post comes as a comment on Mickey's post today:
Mickey (email@example.com) has left you a comment:
I agree, Mickey. Interesting reading from an institutional investor who is sick, SICK! of trying to beat the market by putting 60% of his fund into what he (and the industry) calls 'alternative' investments - things like hedge funds and Private Equity (aka PE). As he sees it, he has to pick lots of hedge funds because going with just one would be too risky. And he has to pick lots of PEs. Same logic. And he suggests that all this complexity and the lack of transparency and the fees ... oh man the fees can be stunning ... are simply not worth it. He wants everybody to stop wanting all those high returns, returns above market performance, and just go back to the good old days, to what he calls Simple Investing - meaning his clients should pay him to select a basket of ... not stocks, no ... they should pay him to select a basket of indexes and that would be simple and provide the highest return on investment.
Well, his Simple strategy would be simple for him, that's for sure. Its not particularly challenging investing to select a pile of index ETFs. And if you get to collect 1% of $10 billion for the trouble, Simple could look very good indeed. (For the math challenged amonst us, that's $100,000,000 per year.)
But why is he complaining about hedge funds? Aren't they worth the extra because they do so well? Well, he thinks that, on the average, hedgies don't actually beat the market. And he may be right. The problem with his logic is, however, this: Some hedge funds do beat the market. By a lot. And over long, long periods of time.
Ironically for him, the one's that do beat the market tend strongly toward one simple strategy - you guessed it - Rule #1. The guys (and they are exclusively guys who are doing this for some reason) who beat, even pound, the market do so by not focusing at all on making money. They just focus on not losing it.
Strange that that works, but it most certainly does. Buffett, Graham, Ruane, Perlmeter, Einhorn, Berkowitz, Robertson, Ackman, Pabrai and many more including me, focus on not losing our capital and yet the results come in spectacularly. Most everybody on this list has a long term track record far above the market average.
The problem for this and most other institutional fund managers is they want their cake and eat it too. They want the security blanket that excessive diversification brings and yet they desperately desire the alpha returns achieved by a focused Rule #1 portfolio. Indeed, it should be obvious that it is impossible to diversity your way into a huge return. The more places the money goes, the less you know about where its going, the more likely a mistake will destroy capital and level the gains down to less than a market level of performance. Diversification is crack for simple minds; it seems like heaven until they wake up one day and discover everyone left. All of the investors headed out the door and over to those awful hedge funds.
I feel this guy's pain. He wants what he can't have - money from lots of investors that he can use to make a mediocre return with. Simple looks so good until its compared to the market destroying results of Rule #1 investing. It looks good to be able to tell investors "I told you so" about sticking with the index because the market always goes up in the long run - and here he is - 5 years after the market collapse - with a compounded annual return of 3.7%. Why isn't everyone applauding? Because of guys like me. When AAII.com can run a simple objective program using my defined strategy and get 20% CAGR in the same 5-year period, most investors are going to prefer that to 3.7%. $100,000 invested with an index oriented fund increased it to $120,000 while the Rule #1 Strategy at AAII increased it to $250,000.
Investors used to believe the academics - that you can't beat the market - until even smarter academics proved that you could and that many hedge fund guys did. From Buffett's famous 24% per year for 50 years to Robertson's 38% per year for 18 years with dozens of audited long-term CAGRs in between, todays investors know its possible and they want it. They are not willing to leave their money with an institutional manager who wants to go back to Simple and charge fees for it. They've discovered that they can get Simple even simpler - just go buy DIA, SPY, QQQ and RUT and you're done. If they want Simple, they learned that they don't need this guy. Simple is as simple does. You want the market ROI, its available for a pittance, no management fees required.
But if you're institutional and you want big alpha returns, diversifying across a pile of hedge funds, paying tons of fees and praying you picked the right mix is probably not going to cut it either. Rule #1 guys are few and far between. Most hedgies use a lot of leverage and complexity. Few of them can hold their institutional clients for more than a few months of sub-market returns. Where the money goes, the industry follows. If institutional money goes to the guy with the hottest track record over the last 6 months, more and more hedge funds are going to lever up and go for the big home runs, all the while trying like crazy to avoid having a bad month. Its a recipe for disaster.
Rule #1 guys don't do that. They go long. They buy when their clients are screaming for them to sell. They don't worry about making alpha. They do it all backward. And, in the long run, they kill the market.
Long term killing the market. That's not what this blog is about. This blog is about learning to avoid losing your money and that focus results in killing the market. Everything we do here should be focused on Rule #1, not on short term complexity and high returns, not on options trades, not on gambles. Let's stick to our knitting, focus on finding great companies at attractive prices and put the complex trades back in pandora's box where they belong. Like this institutional investor wishes he could, we keep it simple, focus on the basics, avoid the losses and in the end come out a big winner.
Now go play.